Understand the ins and outs of accretion/dilution analysis, a critical evaluation method in merger and acquisition deals. This deep dive into the concept elucidates its relevance in assessing post-transaction earnings per share (EPS) and provides comprehensive steps for its calculation.
Key Insights
- Accretion/dilution analysis is a critical evaluation tool in merger and acquisition (M&A) deals to assess the worthiness of a proposed transaction.
- The analysis is centered around determining the effect on the post-transaction earnings per share (EPS), whether it results in an increase (accretion) or decrease (dilution).
- Managers involved in a prospective M&A deal need to consider numerous factors including the negotiation process, global impact, and the compatibility of the merging companies.
- The process of conducting an accretion/dilution analysis involves estimating pro-forma net income and ultimately calculating pro-forma EPS.
- The calculation of pro-forma net income includes various steps such as tabulating the prospective acquirer’s share count, estimating net income for the combined entities, and calculating the new share count of the combined company.
- Before presenting the results of an accretion/dilution analysis, it is important to verify the numbers and maintain professional skepticism about prospective synergies.
Accretion/Dilution Basics
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EPS Impact
Compare combined company EPS to acquirer's standalone — accretive if higher.
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Deal Structure Matters
Cash-financed deals tend to be more accretive than stock-financed.
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Synergies Boost
Cost and revenue synergies improve the EPS calculation.
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Quick Litmus Test
If acquirer P/E > target P/E (after-tax cost of debt adjusted), deal is accretive.
- An accretion/dilution analysis is a simple test used to evaluate the merit of a proposed merger or acquisition deal
- The accretion/dilution analysis determines if the post-transaction earnings per share (EPS) is increased or decreased
- The managers in a prospective M&A deal need to consider many factors such as the negotiation process, the global impact, and the compatibility of the companies
- The process of an accretion/dilution analysis begins with estimating pro-forma net income to eventually arrive at pro-forma earnings per share (EPS)
- An increase in pro-forma EPS is regarded as an accretion, while a decrease is regarded as a dilution
Steps for Accretion / Dilution Analysis
- Estimate a pro forma net income for the combined entities
- Calculate the combined company's new share count
- Tabulate the prospective acquirer’s share count. Factor new shares that would be issued to make the purchase if it's a stock deal
- Divide pro-forma net income by pro-forma shares to arrive at a pro-forma EPS
An increase in EPS is regarded as accretion, while a decrease is regarded as dilution.
Check your numbers before presenting them. Incorporate some professional skepticism on prospective synergies
Accretion / Dilution Calculation
|
Target and Acquirer net income |
Calculate = EPS * share count |
|
Synergies |
Estimate and benchmark |
|
Proforma net income |
Target + acquirer + synergies post tax – interest post tax |
|
New shares issued |
Calculate = equity issued / acquirer share price |
Video Transcription:
Full Video Transcript
Introduction to Accretion/Dilution Analysis
In this video we're going to talk about the accretion/dilution analysis that you would perform for M&A transactions. An accretion/dilution analysis is a simple test used to evaluate the merit of a proposed merger or acquisition deal. The accretion/dilution analysis determines if the post-transaction earnings per share is increased or decreased.
The managers in a prospective M&A deal need to consider many factors such as the negotiation process, the global impact, and the compatibility of the companies. The process of an accretion/dilution analysis begins with estimating pro forma net income to eventually arrive at pro forma earnings per share. An increase in pro forma earnings per share is regarded as an accretion, while a decrease is regarded as a dilution.
Steps for Accretion/Dilution Analysis
So here are the steps for accretion/dilution analysis. First, you need to estimate a pro forma net income for the combined entities. After that, we would need to calculate the combined company's net share count. The third step is tabulate the prospective acquirer's share count, factor new shares that would be issued to make the purchase if it's a stock deal.
And last but not least, divide pro forma net income by pro forma shares to arrive at the pro forma EPS, and then you can calculate EPS accretion and dilution. An increase in EPS is regarded as accretion, while a decrease is regarded as dilution. You need to check your numbers before presenting them to the managers. You need to incorporate some professional skepticism on prospective synergies.
Detailed Accretion/Dilution Calculation
Here's an accretion/dilution calculation in more details. So to calculate target and acquirer net income, you would take earnings per share and multiply it by share count for both companies. For synergies amount, you would estimate and benchmark, and then calculate pro forma net income by summing up target, acquirer, and synergies post-tax and subtracting interest post-tax.
To calculate new shares issued, you would need to take equity issued and divide it by acquirer share price. And for pro forma shares outstanding calculation, you would take shares outstanding and shares issued. After that, you can calculate pro forma EPS, which is pro forma income divided by pro forma shares outstanding.
Then you can calculate the final step for EPS accretion/dilution, which is pro forma EPS divided by acquirer EPS minus one. In the next video, we're going to perform that accretion/dilution calculation in an Excel spreadsheet.
